Question about expatriation from a reader

by Phil Hodgen on May 18, 2011

I received a question today by email and I thought it would be useful to answer it here.

Hello, Phil.  Regarding Form 8854, I’ve been trying (so far unsuccessfully) to get clarification on determining the net worth component for assets shared equally by spouses.  Does each spouse include 100% or 50% of the value of the shared assets in the net worth calculation?  Does the answer depend on the type of shared asset?  We have the following shared assets: joint bank accounts, shares of stock held in a superannuation fund (a grantor trust where we are the only trustees), a house owned by us as joint tenants, and miscellaneous personal items such as furniture, etc.

By the way, I think you should author a new book: Renouncing U.S. Citizenship for Dummies  :-)

Logging Out of Two Systems

For those of you who are going to give up U.S. citizenship (or cancel that permanent resident visa you have), there are two hoops to jump through:

  • Log out of the U.S. citizenship database. There is a nice little bureaucratic dance you go through, complete with paperwork and interviews.
  • Log out of the U.S. tax system. For this, we have Form 8854 from the IRS.

By filling in Form 8854, you will discover whether you are a “covered expatriate” or not. A “covered expatriate” owes tax to the United States, triggered by the cancellation of citizenship. Someone who is not a covered expatriate just has the IRS paperwork to deal with, but no tax to pay.

Form 8854 asks you to fill in a balance sheet and declare your worldwide assets and liabilities. If your net worth exceeds $2,000,000, you are a covered expatriate.

Answer the Question, Phil! (Theory)

See, I’m finally getting around to answering the question. :-)

There is no such thing as a jointly-filed Form 8854. Each expatriating human being files his/her own Form 8854. So what do you do when preparing Form 8854 for one or both spouses of a married couple? Maybe one is expatriating and the other is keeping his/her U.S. citizenship. (We see this happen). Maybe both are expatriating.

How do you figure out the right numbers to put on the Form 8854 balance sheet?

The answer is that the spouses have property rights in their assets that are defined by local law. As a general principle the IRS respects the property rights of parties as those rights are defined by the relevant local law. The IRS only computes the tax consequences of transactions based on those legal rights.

The Easy Situation

So the first answer to this question is simple:

If you can prove with certainty what the husband owns and what the wife owns, under local law, then you have your answer.

For instance, a couple living in a community property jurisdiction (California being the example I know first-hand because, well, I live here and I’m married), by definition all assets acquired during marriage are going to be community property with equal ownership by the spouses, until proven otherwise. (Gross simplification. Do not use this sentence as legal or tax advice in the event of divorce, etc.)

Fixing Uncertainty or Customizing Reality

But what if you can’t prove with certainty exactly what belongs to the husband and what belongs to the wife? Again a simple answer. For this simple answer we turn to that noted tax scholar, Adam Savage:

Section 1041 of the Internal Revenue Code makes transfers between spouses completely tax-free. So, following Adam’s timeless legal advice, we reject the murky, uncertain reality of property rights of the spouses, and substitute a carefully-handcrafted reality in its place. Tax-free.

TL;DR

When one or both members of a married couple decide to expatriate, you’re probably pretty safe dividing the assets in half when preparing each person’s Form 8854.

If you are at all unclear about who owns what, or if it might be useful to have an unequal division of assets between the spouses (oh, hypothetically speaking, the expatriating spouse magically has $1.9 million net worth on his Form 8854 balance sheet while the U.S. citizen spouse retains the remainder of the assets as her separate property), then do a postnuptial agreement to create the reality you’d like to present to the Internal Revenue Service.

Thanks

Thanks S for the question. I hope this helps.

Reader comments (15)

  • Just a thought – if a couple were two different citizenships (one US, the other say European), couldn’t the US citizen transfer assests into his non-US spouse’s name, fill in the 8854 with a net worth under $2M, renounce, and afterwards put their financial house back the way it was?

    Apart from pensions etc, couples are allowed to transfer assets to each other in many countries without a tax penalty.

    I know it can get complicated, but in theory it could be possible.

  • @Don,

    What you suggest would be absolutely possible. He said, whistling and looking at the sky. :-)

    Seriously, though. This is the first line of defense. A U.S. citizen can give away assets tax-free up to $5 million. Current rules, that is. If the recipient of that largesse is a non-U.S. spouse, it doesn’t matter. File the gift tax return. Do the paperwork.

    Ideally that will bring the U.S. citizen’s net worth below the magic $2,000,000 mark. At that point it is an easy expatriation.

    This strategy has the advantage of being legitimate, fully-disclosed, and correct.

    /Phil.

  • Phil

    That was an extremely helpful and very detailed post. This is the sort of thing that other lawyers charge mega-billable hours for. I wonder what happens for property located abroad if the IRS “respect local property law” in say the jurisdiction of upper Avalon.

    Another strategy similar to the one that Don mentioned occurs to me. Gift property to an aging parent who is a non-resident alien, until it gets below the magical mark. Then expat and wait till they pass away (rather morbid, I agree) and leave it to you, assuming their country of residence does not have an estate tax or gift tax (when you gifted them sum). And assuming they don’t go senile till then or marry a young gigolo/bimbette :-)

  • @Wada,

    This would probably work. The primary risk that I can see is an attack by the IRS claiming this is a phony arrangement. “It’s all bull—” is a reasonable attack when the transfer back to the expatriate occurs within a short time. Then the arrangement looks like parking assets with a nominee.

    But leaving the assets with the parents until death and receiving them back via inheritance would be likely to stand. Enough time elapses, wills can be changed, etc. These items introduce real risks that the expatriate might not get the property back. Thus the fact pattern would have a good shot at succeeding.

  • Anonymous says May 19, 2011 9:17 am

    “The primary risk that I can see is an attack by the IRS claiming this is a phony arrangement…”

    Well, the exit tax is a phony tax. Lex talionis.

  • Whether the IRS likes it or not – under current rules you’re allowed to “gift” $5M away to anyone.

    Wait for the legal challenges abroad when FATCA starts biting in 2013 – a new reality will set in for the IRS “this isn’t going to be as easy as Congress thinks.”

  • Thanks a heap for this explanation. I`ve searched high and low on the IRS cite and elsewhere and could not find an answer to this question. And the local accountants in my rural area haven`t heard of 8854.

  • Lorraine says Aug 29, 2011 12:06 pm

    If you have community of property does that mean I would have to list my husband’s (a NRA) personal retirement plans, bank accounts in his name only etc. for the expat tax, and if I did would I divide the values by 2? And, I want to be sure, filing as a covered expat because you didn’t file returns would supersede them coming after you for the years you didn’t file? Is doing the covered expat, if you have less than $626,000 and didn’t file the way to cut all ties with the IRS?

  • The question of community property has not been figured out yet by the IRS, I believe. Your idea is logical — you should only be treated as owning half of the asset. But I don’t know of anywhere that the IRS has discussed this point. With a bit of care you can solidify the question of asset ownership so it will be extremely clear to the IRS. I would suggest that you do this before becoming an expatriate.

    I’m not sure I understand the other questions that you asked. Sorry.

  • Lorraine says Aug 29, 2011 4:17 pm

    If I haven’t filed my income tax forms and FBARs in the past 5 years, I would have to report that I have not complied in Part iV(6). I would be then a covered expat. But my assets are such that I would not pay tax because I would be covered by the $626,000 exemption. I want to know if the IRS would still go after the years I hadn’t filed, or by becoming a covered expat and paying any expat tax if due absolves me of the years I hadn’t filed. Does it wipe the slate clean for the years I hadn’t filed? I mean is it worth taking the chance of filing old returns and Fbars (even when I owe nothing) because they can charge penalties and such, when instead I could become a covered expat on 8854 because I haven’t filed, figure my expat tax, which would be nil because I don’t have many assets, and walk away? Can they turn around after I became a covered expat and settled the expat tax and say “Where’s your 2008-2010 income tax forms?” for example?

  • Lorraine,

    You won’t successfully get out of the USA until you have 5 years of income tax returns on file with the Service. Even if there is no tax due, tax returns will be necessary.

    At the moment the FBAR penalties are not part of the expatriation deal. So file your tax returns and get out of town. Fast. :-)

  • Lorraine says Aug 30, 2011 10:30 am

    I still have to file the FBARs for the previous 5 years, I gather? Can I just file the tax returns and renounce without the FBARs? Can they come after me for not filing FBARs after I have renounced? These damn FBARs are my problem, not the tax returns.

  • Lorraine,

    You’re into the zone where you need legal advice specific to you — what to file, what to put on the paper, when to do it, etc. All of this is done with the end in mind — successful expatriation.

    I would guess though that you’d have to file the FBARs. But you need to talk to someone about this and get guidance.

    Phil.

  • Haresh Jaisinghani says Oct 16, 2011 10:28 pm

    In case of joint income tax fillers, is it allowed to apportion the US income tax liability for the expatriating spouse (based on her/his income) for Form 8854 (Note: Form 8854 is on indivual basis wnereas US income has been filled on join basis) ?

  • would have worked but isn’t there now a tax on inheritances fron non-us persons, if over $100 K (approximately)?